A plain-English overview of legal issues that affect creatives and creators, as understood by someone who works in the business. Posts aren't legal advice, my employer isn't responsible for what I say, subscribe if you like what you see.

Monday, February 24, 2014

Netflix and Comcast enter agreement to speed up streaming: 5 consequences for you and me

I hope you like Netflix. I know I do. Good thing. Because this week the world changed in a way to make Netflix even more likely to be your only real option in streaming media.

Over the weekend of February 22-23 GigaOm broke the story that Netflix and Comcast had entered into some form of peering agreement. In order to understand why this is important and what its consequences will be both for the Internet and entertainment companies as well as for you and me, it's first necessary to understand what a peering agreement is in the first place. GigaOm actually summarizes it pretty well:

Much like your decision to go to one Starbucks over the other (shorter lines, a barista who is more generous with the whipped cream, the distance), multiple factors come into play when the Netflix client determines the server and route it wants to use. So you might end up traveling over a pathway where the parties directly interconnect (Netflix-Comcast), or where there are more than the two parties but the third-party has a peering relationship with the ISP (Netflix-Level 3-Comcast) or where they don’t (Netflix-Cogent-Verizon).

Here's what that means in English (and if you're technical: yes I'm oversimplifying but I don't think I'm introducing inaccuracy):

As you may know, the Internet works by way of packets of data being sent from a source to a destination and then being reassembled on the other side. If packet #2 gets to its destination before packet #1, reassembly has to wait until packet #1 shows up. This wait is one aspect of what we experience as lag.

There are lots of different paths that a block of data can take to get from Point A to Point Z: it can go A-Z, or A-B-Z, or A-B-C-D-E-F-Z, etc.

The more stops (or "hops") each packet takes, the longer it takes to get there.

But if the packet goes through a stop where data from Point A is given special fast-track treatment, it spends a lot less time there. Think about getting on a plane: business-class and economy-class passengers both have to go through security, but business-class ones don't wait in a long line, so they can get through faster. Same kind of thing.

So under a peering agreement Netflix and Comcast would have agreed that Comcast will fast-track Netflix's data. As of this weekend when I was writing it wasn't confirmed whether this was a "settlement-free" agreement (where the fast-tracking goes each way) or where Netflix pays Comcast. The Wall Street Journal was reporting that Netflix was paying which makes sense - Comcast has no need to send traffic down Netflix's network.

After all the worries that were raised from the recent Net Neutrality decision that ISPs would use this to "block Netflix", it may seem that deals like this show that those crying the sky is falling were wrong: this deal proves it. But the way I see it, this deal shows why the whole system is broken, and if you're a creator or even a consumer of content you shouldn't feel reassured at all by these developments.

Here's why.

1. Netflix is now unlikely to challenge the status quo. After the recent Net Neutrality decisions, it is clear that the FCC currently doesn't have the regulatory authority to mandate that ISPs treat all comers equally. But the FCC wasn't the only potentially-interested party. If Company X felt that the ISPs were using their control over the Internet pipe to your house to force you to choose the ISP's offering over Company X's identical offering, that might give Company X grounds to sue under the antitrust laws. After the judgment came down in January, a lot of people hoped Company X might be Netflix. Of all the services that need access to consumers to shove them lots of data, a streaming video provider is right up there. Unlike Hulu, Netflix isn't owned by broadcasters so wouldn't be damaging its other business interests by challenging the status quo. And it has the resources to do it.

Well, no danger of that any longer.

And this matters. You and I don't have standing to challenge this on an industry-wide basis. The best we could do is to find a way to bring a class action against an individual ISP, and even then I don't know if it would work: the contracts we sign usually prohibit class actions, force arbitration, and have all sorts of other procedural scale-tilting mechanisms in favor of the ISPs, and substantively they often allow content throttling and other actions that would make this a really hard case to bring. But an aggrieved competitor would have access to the antitrust laws, with their triple-damages provisions.

2. Unlike TV, ISPs have no obligation to enter into these agreements. So Netflix has signed a contract with Comcast. Why can't other companies do that too? The short answer is: Netflix was big enough to make it worth Comcast's while to negotiate an agreement. A smaller provider might not have the ability to get Netflix's attention, which risks resulting in fewer providers of content.

In the TV world this has been addressed by legislation. For example, under the Telecommunications Act certain local content providers can designate themselves as "must-carry" channels. If a company wants to provide cable TV services in the area where those "must-carry" channels operate the provider must carry those channels as part of its service offering, which means it also has to pay the channel a license fee.

Put aside the specifics of local TV and look at the bigger picture. Every business has to start small. In the TV environment that usually means as a local channel. In the Internet context that means without a lot of funding. To get from small to big, content providers need to have two things: an offering that differentiates themselves from their competitors, and access to the consumers who will choose them over their competitors. Even where a content creator is able to have the first, if the ISPs won't give them the same kind of treatment as Netflix then they'll never get the second. And then you'll never find out about them, and even if you do you'll find the experience so choppy you'll likely stop using them, and then they're gone.

One "side" point that's actually really important. It might seem that my concern here is hypothetical: why wouldn't a company take money from everyone who wants to negotiate a peering deal? The short answer is time and resources. For every company there are deals that are "too small to be worth it". If a deal will only make a company like Comcast $5,000 or even $50,000, there is just no one staffed with the responsibility to make it happen.

Remember that point. It'll come up again.

3. The "walled garden" this deal creates will benefit Netflix over competitors. This is one real problem with regulated industries: once there is a regulation there is a cost to comply. Paying that cost, costs money. And money is something that startups often don't have. But their competitors do. Netflix could afford to pay whatever Comcast required, and can afford to pay the other ISPs too. Will their competitors?

Market stabilization is always to the benefit of established providers.

4. Netflix is not an outlet for average creators. Look at what's available on Netflix: previously-released content, Netflix originals like Orange is the New Black and House of Cards, and continuations of previous content like Arrested Development. Do you think that's the place for small creators to sell their original content? Go back to what I said in #2 above: just like Comcast won't have people to do small deals with small content creators, neither will Netflix. If you don't have a portfolio it can be really difficult to get their attention.

This matters too: it concentrates power into the hands of aggregators who can build a portfolio sufficiently large to be able to deal with Netflix. Again, score one for the big guys.

5. This deal benefits Comcast and larger ISPs too. Do you think Netflix is going to do these deals with every ISP? Or just the ones that it thinks it needs to deal with in order to provide service to the large majority of its customers? Smaller ISPs, the ones that the courts have speculated would come into existence if large ISPs start throttling services because no Net Neutrality rule would mean they can, won't be able to get on Netflix's radar - my #2 again. And so if you want good Netflix you'll have to go to a bigger ISP that can attract Netflix's dollars.

Sometimes I feel like a broken record on this stuff, the way I always see disruption in the entertainment industry eventually being swallowed up by larger and more established interests. I just wish that sometimes I was also wrong.

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About Me

I'm an adjunct professor of Entertainment Law at the University of Washington and the General Counsel of The Pokémon Company International. Before being at Pokémon I was the head lawyer for Microsoft Game Studios. I write a legal blog with practical tips for creators and creatives at www.legalminimum.net and tweet from @LegalMinimum. I'm also a failed standup comic and once narrated romance novel books on tape. So there's that.

Mandatory weasel words: I'm not your personal attorney and I'm not creating an attorney-client relationship with you when you read my posts. If you need specialized legal advice, go hire someone. And my employer isn't responsible for what I say.